Do you have cash in your wallet or money in the bank? Have you ever purchased stocks or bonds? If so, you own a financial asset.
If you are new to the world of personal finance, terms like financial asset might seem like jargon. However, understanding these common topics is an essential step toward financial literacy. Investopedia explains what you should know about financial assets.
What Are Financial Assets?
Financial assets are a type of liquid assets like cash, bank deposits, stocks, bonds, or mutual funds. Because these assets lack intrinsic value — or a physical state in some cases — their value comes from contractual agreements or ownership claims. Their worth can fluctuate based on their risk as well as supply and demand.
Types Of Financial Assets
Generally, assets fall under three categories: real, intangible, and financial.
- Real assets are tangible. These can be a piece of property, like land, real estate, or a substance such as precious metals or commodities like iron, wheat, or oil.
- Intangible assets are not physical, but they still have value. Patents, intellectual property, and trademarks are examples of intangible assets.
- Financial assets fall in the middle and can be either physical or intangible.
As mentioned earlier, the value of a financial asset is based on a predetermined agreement. These contracts dictate not only who (or what) owns the asset but who receives payments from the underlying asset.
Underlying assets can be real (commodities) or intangible (stock futures, contracts). For instance, a commodity like soybeans is a tangible underlying asset. The market value for soybeans is tied to intangible assets like shares. In the same vein, a piece of land for sale is a real asset connected to an intangible financial asset such as real estate investment trusts (REITs).
What Are Common Types Of Financial Assets?
The International Financial Reporting Standards (IFRS), a global regulatory agency, offers several examples of common financial assets, such as:
- Equity instruments like shares
- Contractual agreements that give right of ownership over a financial asset (receivables)
These assets, as well as derivatives, bonds, money market accounts, equity stakes, and others typically have no monetary or market value until they are exchanged for cash.
Besides cash, other common financial assets include:
- Stocks, which never expire. When you purchase a stock, you can keep it indefinitely or sell it. You also become a company shareholder. The returns on your investment are based on the company’s performance.
- Bonds, which governments and companies often use to fund short-term initiatives. When you buy a bond, you are lending the entity the money. The bond details how much the entity owes you, the interest rate, and its maturity date.
- Certificate of deposits (CDs), where you deposit cash at a bank for a particular time. During this period, the money accrues interest at a fixed rate. CD contacts range from as short as three months to as long as five years.
Advantages And Disadvantages Of Highly Liquid Financial Assets
Bank accounts, money market accounts, and cash are the most basic types of financial assets. These are highly liquid, which means you can easily and immediately withdraw money whenever you need it.
But not all financial assets offer the same level of liquidity, or how easily you can convert an asset into cash. When it comes to an asset such as shares, liquidity depends on the market. Liquid markets are easier to convert assets since more investors are ready to buy and sell, and trades can be completed relatively quickly.
Stocks and bonds are less liquid because you do not get your payment until the waiting period between the sell date and settlement date ends. This waiting period typically lasts for two business days, but other types of financial assets could take longer.
Holding high-liquidity financial assets can help enhance your preservation of capital. For example, if you keep your money in an FDIC-insured bank and it fails, you wouldn’t need to worry about losing your money since the FDIC insures losses up to $250,000.
However, the downside to highly-liquid financial assets is that they offer a lower return on investment (ROI). Checking and savings accounts have much lower interest rates compared to investment accounts. As a result, your ROI would be much smaller than CDs, investment accounts, and other assets with less liquidity.
- Chen, James. “The Money You Can’t See: Financial Assets.” Investopedia, Investopedia, 16 Sept. 2020, www.investopedia.com/terms/f/financialasset.asp.